General Schedule of Marginal Efficiency of Capital (MEC)

The general marginal efficiency of capital (i.e., the marginal efficiencies of all types of capital assets during a given period) represents the schedule of the marginal efficiency of capital.

ADVERTISEMENTS:

Table 2 The Schedule of the Marginal Efficiency of Capital:

Volume of Investment (in crores of rupees)

Marginal Efficiency of capital (in per cent per annum)

10

10

20

9

30

8

40

7

50

6

60

5

ADVERTISEMENTS:

The MEC schedule can be prepared by listing the various values of the marginal efficiency of capital that are associated with different volumes of investment. Such a schedule is illustrated in Table 2.

Table 2 indicates that, under the given circumstances and conditions, if the volume of investment is Rs. 10 crores, the marginal efficiency of capital will be 10 per cent a year. When the volume of investment increases, the marginal efficiency of capital declines. Thus, if the investment is Rs. 60 crores, the marginal efficiency of capital is only 5 per cent as against the initial 10 per cent.

Under the given conditions, the marginal efficiency of capital goes on decreasing as the volume of investment increases. The reasons for this declining tendency of the MEC are said to lie in the effects of the increase in the volume of investment. First, as the volume of investment increases, the expected annual returns or the prospective yields of the capital assets decrease.

This is because as more and more capital assets are produced, they will have to be used with the given amount of other factors of production which may be inelastic in their supply, and hence their expected net marginal productivity tends to fall.

Even if we assume the factors of production to be relatively elastic in supply, along with the capital, then, too the expected marginal productivity (i.e., the money value of marginal product which is obtained by multiplying the marginal physical product with the price) of the capital asset will diminish, when the marginal unit of a particular commodity cannot be sold without reducing its price.

Thus, with a given supply price, when the prospective yield of a capital asset decreases, the marginal efficiency of capital will obviously diminish, as it is the difference between the prospective yield and the supply price.

Second, it is also possible that as the volume of investment increases, the supply price of capital may rise. When more and more capital goods are produced, the capital goods industries may face the law of diminishing returns so that the marginal cost of producing these assets may start rising.

Moreover, with an increase in investment in capital goods, the demand for factors of production in the capital goods industries and, in view of scarcity of such factors, their prices may rise; this will also add to the cost of production.

Thus, the supply price of the replacement cost of the capital assets will rise as the volume of investment increases. Hence, with given prospective yields, when the supply price increases, the MEC is bound to diminish. It follows that if prospective yields start rising as the volume of investment increases, the MEC will diminish at a faster rate.